Chapter 2: Stakeholders, Managers, and Ethics

CHAPTER 2: STAKEHOLDERS, MANAGERS, AND ETHICS

LEARNING OBJECTIVES

1. Identify the various stakeholder groups and their interests or claims on an organization.

2. Understand the choices and problems inherent in distributing the value an organization creates.

3. Appreciate who has authority and responsibility at the top of an organization, and distinguish between different levels of management.

4. Describe the agency problem that exists in all authority relationships and the various mechanisms, such as the board of directors and stock options, which can be used to help control illegal and unethical managerial behavior.

5. Discuss the vital role that ethics plays in constraining managers and employees to pursue the goals that lead to long-run organizational effectiveness.

CHAPTER SUMMARY

Organizations are embedded in a complex social context that is driven by the needs and desires of its stakeholders. Organizations exist because of their ability to create value and acceptable outcomes for stakeholders. The two main groups of stakeholders are inside stakeholders and outside stakeholders. Effective organizations satisfy, at least minimally, the interests of all stakeholder groups. Theproblems that an organization faces as it tries to win stakeholders’ approval include choosing which stakeholder goals to satisfy, deciding how to allocate organizational rewards to different stakeholder groups, and balancing short- and long-term goals. Shareholders delegate authority to managers to use organizational resources effectively. The CEO, COO, and top-management team have ultimate responsibility for the use of those resources effectively.

The agency problem and moral hazard arise when shareholders delegate authority to managers, and governance mechanisms must be created to align the interests of shareholders and managers to ensure managers behave in the interests of all stakeholders. Ethics are the moral values, beliefs, and rules that establish the right or appropriate ways in which one person or stakeholder group should interact and deal with another. Organizational ethics are a product of societal, professional, and individual ethics. The board of directors and top managers can create an ethical organization by designing an ethical structure and control system, creating an ethical culture, and supporting the interests of stakeholder groups.

CHAPTER OUTLINE

2.1 Organizational Stakeholders

Organizations exist because of their ability to create value and acceptable outcomes for various groups of stakeholders,people who have an interest, claim, or stake in an organization, in what it does, and in how well it performs. In general, stakeholders are motivated to participate in an organization if they receive inducements that exceed the value of the contributions they are required to make. Inducementsinclude rewards such as money, power, and organizational status. Contributionsinclude the skills, knowledge, and expertise that organizations require of their members during task performance. The two main groups of organizational stakeholders are inside stakeholders and outside stakeholders. (Refer to Table 2.1)

Inside Stakeholders

Inside stakeholders are people who are closest to an organization and have the strongest or most direct claim on organizational resources: shareholders, managers, and the workforce.

• Shareholders are the owners of the organization, and, as such, their claim on organizational resources is often considered superior to the claims of other inside stakeholders.
• Managers are the employees responsible for coordinating organizational resources and ensuring that an organization’s goals are met successfully.
• An organization’s workforce consists of all non-managerial employees.

Organizational Insight 2.1: Unethical Managers at a Peanut Company

The fall of Parnell and his business shows the devastating consequences of ethical lapses on the part of senior management. The need for managers to run their organizations ethically is vital as the public relies on the basic integrity, ethics, and honesty of food industry managers to make food that is safe to eat.

Question: What led to the closedown of PCA’s operations?

Answer: In 2009, a major nationwide outbreak of salmonella poisoning was traced by the Food and Drug Administration (FDA) to the peanut butter produced by the Blakely plant of PCA. PCA’s contaminated peanut butter had caused over 600 illnesses, nine deaths, and the largest ever food recall in the country. This led to its closure.

Question: Why did Parnell fail to give due attention to food safety regulations at his plants?

Answer: Parnell was worried about maximizing his profits, especially when prices of peanut products had started to fall. He used contaminated peanuts and avoided salmonella tests to reduce his operating costs.

Outside Stakeholders

Outside stakeholders are people who do not own the organization and are not employed by it, but they do have some claim on or interest in it.

• Customers are the largest outside stakeholder group. The money paid for a product is a customer’s contribution to the organization. Unless they get value, customers withdraw monetary support, and the company loses a stakeholder.
• Suppliers contribute to the organization by providing reliable raw materials and component parts that allow the organization to reduce uncertainty in its technical or production operations and thus reduce production costs. Suppliers have a direct effect on the organization’s efficiency and an indirect effect on its ability to attract customers.
• The government wants companies to compete fairly and comply with laws pertaining to employee pay, safety, discrimination, and other issues. The government contributes to organizations by standardizing rules.
• Trade unions directly impact a company’s productivity and effectiveness, but union demands can conflict with shareholder demands.
• Local communities have a stake in the performance of organizations because employment, housing, and the general economic well-being of a community are strongly affected by the success or failure of local businesses.
• The general public is happy when organizations compete effectively against overseas rivals as the present and future wealth of a nation is closely related to the success of its business organizations and economic institutions.

Organizational Insight 2.2: BP Has Problems Protecting Its Stakeholders

In 2005, the United States witnessed one of its largest ever explosions at the British Petroleum plant situated 40 miles from Houston. Despite the aftermath of the incident, the company was found to breach the security restrictions placed upon it a second time in a row and was fined. This prompted the company to take remedial measures. However, in 2010, an accident on its oil drilling unit killed a few employees and brought about a full-fledged oil spill.

Question: What was the cause of the 2005 British Petroleum explosion?

Answer: Investigations revealed that the 2005 explosion occurred because BP had relaxed safety procedures at its Texas City refinery to reduce operating costs. The U.S. Occupational Health and Safety Association (OSHA) decided the 2005 explosion was caused by defective pressure relief systems and by poor safety management programs.

Question: After the 2007 accident, what measures did British Petroleum take?

Answer: After the 2007 accident, BP’s board of directors decided to move quickly. They fired the CEO and many other top managers and appointed a new CEO, who was instructed to make global refinery safety a key organizational priority. The board also decided to make a substantial portion of the future stock bonuses for the CEO and other top managers dependent on BP’s future safety record. Additionally, the board committed over $5 billion to improving safety across the company’s global operations.

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2.2Organizational Effectiveness: Satisfying Stakeholders’ Goals and Interests

Organizations are coalitions of stakeholders who bargain to balance inducements with contributions. An organization must minimally satisfy the interests of all stakeholders who often have conflicting goals. To win stakeholder approval, the organization faces the problems of competing goals, allocating resources, and balancing short- and long-term goals.

Competing Goals

An organization’s choice of goals has political and social implications. One view is that shareholders own the company, thus managers should maximize shareholder wealth. Yet ownership and control are separated because managers control the company and can pursue personal interest. They may focus on short-term profits instead of long-term growth or avoid risk taking because they control their own salaries.

Allocating Rewards

Another major problem that an organization has to face is how to allocate the profits it earns as a result of being effective among the various stakeholder groups. Reward allocation is important because it motivates stakeholders, yet it is difficult to determine the distribution of excess rewards.

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2.3 Top Managers and Organizational Authority

Authority is the power to hold people accountable for what they do.Shareholders are the legal owners of the corporation, and they are represented by a board of directors, who act as trustees.The board has the legal authority to hire, fire, and discipline top management.However, the responsibility of using organizational resources to create value is delegated to managers.(Refer to Figure2.1)

There are two kinds of directors: inside directors and outside directors. Inside directors are directors who hold offices in a company’s formal hierarchy; they are full-time employees of the corporation. Outside directors are not employees of the company; many are professional directors who hold positions on the board of many companies, or they are executives of other companies who sit on other companies’ boards.

The Chief Executive Officer

The CEO is the person ultimately responsible for setting organizational strategy and policy. The CEO is at the top of the hierarchy and can influence organizational effectiveness and the decision-making process in the following five ways:

1. The CEO is responsible for setting an organization’s goals and designing its structure.

2. The CEO chooses key executives to fill top-level positions in the hierarchy.

3. The CEO determines top management’s rewards and incentives.

4. The CEO controls the allocation of scarce resources among an organization’s functions and divisions.

5. The CEO’s actions and reputation influence inside and outside stakeholders’ opinions of the organization and impact the organization’s ability to attract resources from its environment.

The Top-Management Team

The president is the person who has a position directly below the CEO and generally is called the chief operating officer (COO). In most companies, the president takes responsibility for managing the organization’s internal operations, and the CEO takes responsibility for managing the organization’s relationship with external stakeholders and for formulating a long-range business plan.

At the next level of top management are the executive vice presidents. People with this title have responsibility for overseeing and managing a company’s most significant line and staff responsibilities. A line roleis held by managers who have direct responsibility for the production of goods and services. A staff role is held by managers who are in charge of a specific organizational function such as sales or R&D.

The CEO, COO, and the executive vice presidents are at the top of an organization’s chain of command. Collectively, managers in these positions form a company’s top-management team,the group of managers who report to the CEO and COO and help the CEO set the company’s strategy and its long-term goals and objectives. All the members of the top-management team are corporate managers,whose responsibility is to set strategy for the corporation as a whole.

Other Managers

Other corporate managers include senior vice presidents and vice presidents.Vice presidents report to senior vice presidents, who report to executive vice presidents.

Companies may also have general managers or divisional managers.These managers are present only in companies that are organized into separate business divisions. These managers are divisional management and not corporate management and they determine policies for the divisions they run instead of objectives for the organization as a whole. Divisional managers generally report to a member of the top-management team.

Managers at the next level are called functional managers; these managers are in charge of a certain function, like marketing or finance. Functional managers are responsible for developing capabilities in their area that lead to core competences.

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2.4 An Agency Theory Perspective

Agency theory is useful for understanding the relationships between various levels of management.A relationship exists when one party (the principle) delegates decision-making authority or control to another (the agent).The agency problem is a problem in determining managerial accountability that arises when delegating authority to managers.

The Moral Hazard Problem

Two conditions lead to the existence of a moral hazard: (1) a principal finds it very difficult to evaluate how well the agent has performed because the agent possesses an information advantage, and (2) the agent has an incentive to pursue goals and objectives that are different from the principal’s. Self-dealingis the term used to describe the conduct of corporate managers who take advantage of their position in an organization to act in their own interests rather than in the interests of other stakeholders, such as taking advantage of opportunities to misappropriate corporate resources—including secret information.

Solving the Agency Problem

Governance mechanisms are forms of control that align the interests of principal and agent so both parties have the incentive to work together to maximize organizational effectiveness.

Stock-based compensation schemes are monetary rewards in the form of stocks or stock options that are linked to the company’s performance.

Promotion tournaments and career paths: One way of linking rewards to performance over the long term is by developing organizational career paths that allow managers to rise to the top of the organization.

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2.5 Top Managers and Organizational Ethics

Ethics are the inner guiding moral principles, values, and beliefs that people use to analyze or interpret a situation and then decide what is the “right” or appropriate way to behave. Following ethical principles when faced with ethical dilemmas or situations when onemust decide whether or not they should act in a way that benefits someone else, even if it harms others and isn’t in their own interest are a major part of corporate governance today. The essential problem in dealing with ethical issues, and thus solving moral dilemmas, is that no absolute or indisputable rules or principles can be developed to decide if an action is ethical or unethical.

Ethics and the Law

The society as a whole, using the political and legal processes, creates, passes, and enforces laws that specify what people and organizations can and cannot do along with sanctions and punishments for the same. However, neither laws nor ethics are fixed principles and since no absolute or unvarying standards exist to determine how we should behave, people are caught up in moral dilemmas and have to learn to make ethical choices.

Ethics and Organizational Stakeholders

Ethics guide managers in their decisions about what to do in various situations. Ethics also help managers decide how best to respond to the interests of various organizational stakeholders.

Philosophers have debated for centuries about the specific criteria that should be used to determine whether decisions are ethical or unethical. The three models that have been suggested by them are the utilitarian, moral rights, and justice models. (Refer to Table 2.2)

Sources of Organizational Ethics

The three principal sources of ethical values that influence organizational ethics are societal, group or professional, and individual. These three sources of ethics collectively influence the ethics that develop inside an organization, or organizational ethics, which may be defined as the rules or standards used by an organization and its members in their dealings with other stakeholders groups. Each organization has a set of ethics; some of these are unique to an organization and are an important aspect of its culture.

Societal ethics are codified in a society’s legal system, in its customs and practices, and in the unwritten norms and values that people use to interact with each other.

Professional ethics are the moral rules and values that a group of people use to control the way they perform a task or use resources. Usually people internalize the rules and values of their profession, just as they do those of society, and they follow these principles automatically in deciding how to behave.

Individual ethics are the personal and moral standards used by individuals to structure their interactions with other people. Personal ethics are also the result of a person’s upbringing and may stem from family, friends, religious membership, or other significant social institution. Personal ethics influence how a person acts in an organization.

Organizational Insight 2.3: Is it Right to Use Child Labor?

In recent years, the number of U.S. companies that buy their inputs from low-cost foreign suppliers has been growing, and concern about the ethics associated with employing young children in factories has been increasing. Many U.S. retailers who typically buy their clothing from low-cost foreign suppliers have policies that dictate their foreign suppliers not employ child labor; they also vow to sever ties with any foreign supplier found to be in violation of this standard. However, retailers differ widely in the way they choose to enforce this policy and in places like Guatemala, a very high proportion of the work is still done by children who work long hours and receive little pay.

Question: What is the Economist’s stance on the issue of child labor?

Answer: According to the Economist, though child labor is not desirable, citizens of the rich countries need to recognize that in poor countries children are often a family’s only breadwinners. Thus, denying children employment would cause whole families to suffer, and one wrong (child labor) might produce a greater wrong (poverty). Instead, the Economistfavors regulating the conditions under which children are employed.